Sunday, April 27, 2008

Pilgrimage Part V: Budding Buffetts and The Best of All Worlds

Mr. McGuire: I want to say one word to you. Just one word. Benjamin: Yes, sir.
Mr. McGuire: Are you listening?
Benjamin: Yes, I am.
Mr. McGuire: Plastics.
Benjamin: Just how do you mean that, sir?
—The Graduate

The questions are asked politely and with great respect.

Each shareholder first states his or her name and where they live, and then proceeds to ask whatever is on their mind. Those are the rules.

The rules have been provided in a pre-meeting information package that goes to each shareholder, along with the four plastic “Shareholder” badges each shareholder receives so they may take along friends or family. (I’m here courtesy of a long-time friend and Berkshire shareholder).

The information package also has other vital information, including all the weekend shareholder events at various Berkshire-owned companies, not to mention the locations of the half-dozen Dairy Queens in the area.

After identifying themselves, most of the shareholders gush thanks to Warren and Charlie for this wonderful gathering, for their willingness to share their wisdom, and for the long-term benefits they have accrued by owning Berkshire-Hathaway stock.

At this point, the questions tend to diverge: professional investors from New York City tend to ask tightly scripted questions about potential credit problems and the derivatives market, while long-time shareholders ask more loosely constructed, but further-ranging questions, including one rambling, hard-to-follow query about Charlie Munger’s view of John and Abigail Adams.

Aside from an obviously prepared-for moment when a quiet, respectful female from the Hoopa Valley Tribe asks Buffett whether he is willing to meet with tribal leaders regarding their concerns over a Berkshire subsidiary’s dams on the Klamath River—and, unscripted, breaks down, crying—they come out of left, right, and center field.

Buffett fields them all the same way: straight ahead, spending no less than five minutes on any question (except one—more on that one later). For example, he tells the Hoopa Valley Indian that his hands are tied, because, as a condition of buying the regulated energy supplier which owns the Klamath River dams, he signed an affadivit that he would do nothing to influence regulatory matters governing the dams...and he holds up the signed papers for all to see. (The gesture falls flat; we expect him to be willing to at least listen to what they have to say).

Still, he will not blow off a question or shorten his answer regardless of how similar the question might be to one previously asked, even though many of the questions are variations on a handful of themes.

I decide this is for two reasons: first, these are shareholders asking questions, not merely Wall Street hotshots, and they have a right to be answered in the same thoughtful way they’ve asked their questions.

Furthermore, Buffett’s mind is so precise that since every question, no matter how similar it might be to one already asked, is slightly different, Buffett can draw distinctly nuanced responses each time.

Of all the general themes, the second most common comes from younger members of the audience, generally eager young males—but also a ten year old girl from Kentucky—who want to know what career advice Buffett would give them.

The first time it is asked, a seventeen year old from San Francisco, attending his “tenth consecutive meeting,” wants to know:

“What should I do to become a great investor?”

Buffett’s emphatic answer reminds me of “The Graduate,” when Mr. McGuire famously tells Dustin Hoffman’s character, Benjamin, that one word—“Plastics”—as if it is the key to the universe.

Buffett says:

“Read everything you can.”

It is advice Buffett will give in different ways throughout the morning and afternoon.

For Buffett strongly believes—and Munger later concurs—it was the reading he did in his formative years that shaped his approach to investing and prepared the groundwork for the next fifty mind-bogglingly successful years.

And he’s not kidding when he says to “read everything you can”:

“When I was ten,” he says, “I’d already read every book in the Omaha Public Library with the word ‘finance’ in the title.”

Buffett does not advise reading any particular books, nor does he steer the budding Buffetts towards any particular investment style, even though the impact of Benjamin Graham’s “The Intelligent Investor” on Buffett is widely known.

Rather, he advises reading everything possible to find the style that suits the individual:

“If it turns you on, it probably will work for you.”

Buffett also recommends investing, “on a small scale,” to learn the trade. “Invest, don’t just read.”

Charlie Munger chimes in, suggesting a logical approach typical of almost—almost—everything Munger will say during the session (more on that later):

“Ask (yourself) ‘What do you own and why do you own it?’ and if you can’t answer that, you aren’t an investor.”

Buffett concurs, and repeats what he has told his students over the years:

“If you can’t write an essay describing ‘why I’m going to buy the entire company at the current valuation,’ you have no business buying 100 shares of stock.”

As I said, questions from budding Buffetts will prove to be the second most frequent of the day.

By far the most frequently asked questions concern Buffett’s view of the current investment environment.

The first time a variation on this theme comes up, it is asked by a Japanese investor eager to hear Buffett’s view of the current attractiveness of U.S. corporations.

Buffett replies by marveling at the fecund level of U.S. corporate profits, noting that companies are achieving “20-25% returns on tangible equity versus 4.75% bond rates,” and this is “extraordinary.”

He means that, like most things, quite literally:

“Corporate profits [measured] as a percent of Gross Domestic Product have increased from 4-6% to 8%..." He spreads his hands widely apart. "That's a huge change [from previous business cycles].”

He finds this not only “extraordinary,” but unsustainable: “[It is] the best of all worlds; and history has shown [these extremes] don’t last.”

But he does not expect things to get a lot worse any time soon. Asked about the potential for a credit crisis, he says quite simply, “The Fed doesn’t want to contract credit.”

“The last real credit contraction was thirty years ago,” he notes, and says he finds it unlikely to be repeated (the 1998 Long Term Capital crisis “was a credit seize-up,” not a credit contraction, according to Buffett).

Buffett’s generally complacent view of stocks appears to stem mainly from a comparison of equity valuations versus low-yielding bonds; and his long-term preference for owning businesses rather than debt instruments will come across throughout the day, in many different ways.

“Today, if you give me a twenty year time horizon, I’d buy equities versus a 20 year bond.”

“I would not want to own a 4 ¾% bond.”

“We’re going to want to get a significantly higher return of cash on something we buy, compared to a treasury-bond.”

Shareholders trying to square Buffett’s less-than-ebullient view of the current return potential for stocks (except as compared to bonds) with the fact that he spent $5-plus billion to buy stocks in the first quarter of the current year get a typically facile, but, to the crowd, acceptable answer:

“Have we changed our standards? I don’t think so…but if you haven’t had a date in a month….” He shrugs, and the audience laughs.

Munger adds straightforwardly: “We won’t make the kind of returns on these we made on investments 10-15 years ago.”

To which Buffett says emphatically:

“We won’t come close.”

Question answered, Buffett moves on, checking off a number on a sheet he keeps on the table before him, and calling for a question from the next microphone.

The question comes from a man who sounds a bit too breathless and a bit too serious and a bit too on edge—like the guy who appears from out of nowhere while you’re filling up your car at a gas station and tells you he lost his wallet, has no money, and needs gas to get to his mother’s house three towns away…and can you give him any money?

What the man at the microphone wants is Buffett’s view of the naked short-selling crisis supposedly sweeping through America’s financial markets.

And, while I’m a sucker for the guy at the gas station and usually give him five bucks to get him on his way, Buffett’s answer will not be exactly what this man is hoping for.

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.

3 comments:

I winced when I read Buffett's comment to read every book you can with finance in the title. I read lots of books on investing and what a disservice they did for me. All the benchmarks and guideposts for investing turned out to be useless. Guideposts like NEVER BUY A STOCK WHEN THE P-E RATE IS HIGHER THEN ITS GROWTH RATE. These days stocks like KO with maybe 5% growth sport p-e 's of 20. Thanks for the advice. Or NEVER BUY STOCKS WHEN THE DIV RATE FALLS BELOW 3% . Nice. So you exited the market at dow 2800. And your still on the sidelines 10 k points higher. Or GET OUT OF STOCKS WHEN TOBIN'S Q RISES ABOVE .60 . Great. Now you've been out since about "93-94 and only missed 9 k on the dow. I've found all of it just background noise that is nothing more than a distraction. Even Buffett contradicts himself with conflicting statements on the same subject. Ex. He's quoted as saying " I do not believe in selling a good co just because it may fetch a seemingly rich price today". OK Buy and hold. But then last year in his letter to shareholders, he laments NOT selling KO when it approached $90 per share back in '97 I think was, calling it a several billion dollar mistake. Thats what I call talking out of both sides of your mouth. Sorry, Warren, its one or the other. Ya can't have it both ways. But the polite folks at the meeting aren't about to confront hypocritical talk from the master. My rule about investing is that there are no rules and they're broken all the time.

Not that it matters, but I interpreted Buffett’s advice in a more general way. In college, I had a part-time, loosely supervised job in a boutique law firm. Having more time on my hands than work, I read every pleading, brief, motion, deposition, court opinion that I could lay my hands on and still look busy. After four years I had accumulated knowledge base of law which has provided an outline of legal boundaries which I still utilize today. I wouldn’t consider representing myself in a critical matter based on my self-guided exploration of law, however I can size up legal bulls### without getting billed. I believe what Buffett was describing was the discovery of his passion for finance and all it’s facets which drove (love that word) him to read everything on the subject.